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On March 7, 2017, the US Department of Commerce, Department of Justice and Department of Treasury jointly announced that Chinese telecom equipment maker ZTE Corporation has agreed to plead guilty and enter into related civil settlements for violating US export controls and sanctions that prohibit the export of US-origin goods to Iran and North Korea. Pursuant to the settlement agreements and the criminal plea (which is subject to judicial approval), ZTE will pay a total of up to $1.19bn in fines and forfeitures, marking the largest ever penalty exacted by the US government in an export controls case.

Background

ZTE Corporation is one of the world’s largest telecommunications equipment makers and a major vendor of smartphones in the United States, selling handset devices to various US carriers. ZTE sources certain of its parts and components from various US suppliers.

According to the settlement documents, ZTE engaged in an “elaborate scheme” between January 2010 and March 2016 designed to ship equipment incorporating over $32m worth of US-origin items to Iran and North Korea in violation of Commerce’s Export Administration Regulations (EAR) and OFAC’s Iranian Transactions and Sanctions Regulations (ITSR), which prohibit the export of non-US goods incorporating certain US content. The items at issue that ZTE shipped included routers, microprocessors, servers, databases and other items controlled under the EAR for national security, encryption, regional security and anti-terrorism reasons. ZTE employees also took steps to avoid detection, including the use of shell companies, misleading sales system data and, most prominently, the formation of a 13-member “Contract Data Induction Team” specifically tasked with destroying or concealing materials relating to ZTE’s Iran business. Members of the Contract Data Induction Team were required to sign a non-disclosure agreement providing for a penalty of 1m renminbi (approximately US $150,000) payable to ZTE, and the team’s emails were reportedly deleted on a nightly basis. As such, ZTE was accused not only of taking steps to conceal the transactions and destroy records related to its exports to sanctioned countries, but also of imposing a system designed to punish any potential whistleblowing by the team tasked with implementing the scheme.

Furthermore, although these activities were temporarily halted in 2012 following the launch of an investigation by numerous authorities, they were resumed shortly thereafter reportedly at the direction of certain members of ZTE’s senior management, who were ultimately discharged in 2016. ZTE also allegedly concealed information from its outside counsel and accountants relating to the shipments and caused counsel to make materially false statements to investigators during the course of the inquiry.

ZTE’s settlements and plea agreement are notable for their size: ZTE will pay $430,488,798 in criminal fines and forfeitures, $100,871,266 to Treasury’s Office of Foreign Assets Control (OFAC), and $661m to Commerce’s Bureau of Industry and Security (BIS), with $300m suspended during a seven-year probationary period. In addition to collectively constituting the largest ever export controls-related penalty imposed by the US government, ZTE’s settlement with OFAC is the largest penalty ever imposed by OFAC against a non-financial institution, and the criminal fine represents the largest criminal fine levied to date in connection with a charged violation of the International Emergency Economic Powers Act (IEEPA).

ZTE’s settlement agreement with BIS further provides for ongoing audit and compliance requirements, including the appointment for three years of an independent compliance monitor, and a suspended seven-year denial of export privileges that could be triggered should ZTE fail to comply with the terms of the settlement. Notably, the plea agreement expressly leaves open the possibility of criminal prosecutions targeting individuals involved in the misconduct.

Five Key Takeaways

US export controls and sanctions can broadly reach conduct outside of the United States. The ZTE settlement reaffirms the broad jurisdictional reach of US export controls and sanctions laws: ZTE is a Chinese company, but was subject to the jurisdiction of US export controls and sanctions regulations based on ZTE’s incorporation of certain US-origin content into its non-US manufactured goods. As such, exporters of goods from outside of the United States that use parts, components, or technologies from the United States should carefully consider whether their exports around the world may be subject to US export controls and sanctions restrictions.

Individual accountability may continue to be an enforcement priority. The plea agreement’s explicit carve-out for individual prosecutions may foreshadow the continued emphasis on individual accountability in connection with corporate wrongdoing, as outlined in the September 9, 2015 Yates Memorandum.

Ongoing violations and failure to immediately cooperate can result in hefty penalties. The magnitude of the penalty in this case, especially relative to similar prior enforcement actions, highlights the weight given to cooperation (or non-cooperation) in export controls and sanctions investigations. ZTE’s fines and forfeitures total more than 37 times the value of the US-origin items involved, which appears to be attributable not only to the reportedly intentional conduct involved, but also to ZTE’s ongoing concealment and violation of export controls and sanctions after the investigation began.

Supply chain and sourcing are essential parts of export controls and sanctions compliance. A complete picture of the potential impact of export controls and sanctions often requires a full understanding of supply chain sourcing and a clear assessment of how the US export controls and sanctions rules apply to the goods, their contents and ultimate destinations. Without the right information and advice at hand, it may be difficult or impossible to discern whether goods shipped by non-US entities from outside of the United States to sanctioned destinations – which might otherwise be permissible – are subject to the jurisdiction of US export controls and therefore would constitute breaches of US export controls and sanctions.

Significant export controls and sanctions investigations and enforcements are not limited to financial institutions. Although the largest sanctions settlements to date have been with financial institutions, non-financial institutions bear a greater risk of violating export controls, which can also be violations of US sanctions laws and trigger substantial penalties.